Dataline A look at current financial reporting issues - PwC

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PwC observation: The definition of a lease and whether an agreement is or contains a lease will become a significant area of focus for both lessees and lessors. For potential lessees, it will mean the difference between contracts reflected on the balance sheet (other than short-term leases) under the new lease model and contracts accounted for off-balance sheet as executory contracts. This is not an all or nothing evaluation — the contract may include both a lease and a service (or non-lease executory cost) component, requiring the apportionment of contract consideration. For potential lessors, it will determine whether income recognition relating to some or all of a contract is governed by the lease model or by the general revenue recognition model and how contract assets should be presented and measured. .52 The boards also reaffirmed the "specified asset" and "right to control" principles that an entity would apply to determine whether a contract contains a lease. This requires assessing whether: a. The fulfillment of the contract depends on the use of a specified asset; and b. The contract conveys the right to control the use of a specified asset for a period of time. .53 However, while the boards reaffirmed these two principles, the revised ED would change the guidance for applying them in determining whether an arrangement contains a lease or is a service contract in its entirety. The changes are expected to address specific problems that exist in applying the current lease definition to certain types of transactions (e.g., power purchase arrangements) and better align the right to control concept with other convergence projects, such as revenue recognition and consolidation. PwC observation: There is an expectation that the boards will continue to revise the wording used to define a lease when drafting the revised ED. Although, the drafting revisions may appear minor, we think that they may change whether certain arrangements with significant service elements are within the scope of lease accounting. In addition, although the boards left the core definition of a lease largely intact, potentially significant interpretive guidance is expected, which may change some of the existing conclusions from those reached under today's guidance. Transition .54 The revised ED is expected to require either a full retrospective approach or allow both lessees and lessors options to elect certain reliefs and apply alternative transition approaches. The reliefs are intended to alleviate the burden of applying a full retrospective approach (e.g., providing simplifications to transition discount rate assumptions) and, for lessees, mitigate the front-loaded expense recognition pattern that would result from the transition approach proposed in the initial ED. If elected, these reliefs would be applied to all leases that are outstanding as of the beginning of the earliest comparative period presented. .55 All evidence available to the lessees and lessors through the effective date can be used to measure the lease term and variable lease payments at transition. For example, if a lessee exercised a renewal option prior to the effective date of the new guidance, it could reflect that throughout the comparative periods without having to determine whether there was a significant economic incentive to extend the term of the lease in prior periods. For leases with payments based on an index or rate, this would mean using the actual National Professional Services Group | CFOdirect Network – www.cfodirect.pwc.com Dataline 20
index or rate that was applicable for historical periods and the index or rate as of the effective date for future periods when measuring lease assets and lease liabilities at transition. PwC observation: It is unclear how lessors that apply existing operating lease accounting but will not qualify for the receivable and residual approach will account for transition related matters (e.g., changes in the accounting for variable lease payments and estimates of lease term). The boards have not commented if this issue will be addressed in the revised ED or if it will be discussed as part of redeliberations that take place after comments are received on the revised ED. .56 When lessees and lessors elect to apply alternative transition approaches, lease prepayments and lease accruals relating to existing operating leases with uneven lease payments could lead to an adjustment to the right-of-use asset at the transition date (for lessees) and a transition adjustment to the cost basis in the underlying asset that is derecognized (for lessors applying the receivable and residual approach). PwC observation: When a lessee has an existing operating lease that qualifies for the I&A expense recognition approach under the revised ED and the lessee applies the modified retrospective approach to transition, there will be lease expense recorded as an adjustment directly to retained earnings at transition, rather than in the income statement. This is expected to provide entities with higher total profits over the remaining term of the lease than would be the case under the existing operating lease accounting model, under a full retrospective approach at transition, or when the SLE approach is applied under the revised ED. For lessors, adjusting the cost basis of the underlying asset for any prepaid or accrued lease payments will affect both the "deferred" and "day 1" profit recognized upon transition as an adjustment to beginning retained earnings. Conceptual concerns may exist as to why any prepaid or accrued lease payments arising after the inception of the lease should affect the calculation of deferred profit for a lessor applying the receivable and residual approach. .57 Specific transition guidance is also provided for certain lease arrangements. This includes the: Elimination of leverage lease accounting with a leverage lease lessor required to apply the general lessor transition approach. Continuation of existing sale and leaseback accounting for transactions that resulted in capital lease classification. Re-evaluation of the sale conclusions based on the criteria in the proposed revenue standard for sale and leaseback transactions that resulted in operating lease classification or where the sale recognition criteria previously were not met. If the new revenue criteria are met, a seller/lessee would measure lease assets and lease liabilities in accordance with the core guidance in the revised ED and would recognize any deferred gain or loss in opening retained earnings at transition. National Professional Services Group | CFOdirect Network – www.cfodirect.pwc.com Dataline 21
Page 1 and 2: Dataline A look at current financia
Page 3 and 4: .4 In June 2005, the Securities and
Page 5 and 6: .9 In early 2011, the boards began
Page 7 and 8: .14 Although the project proposes c
Page 9 and 10: Potential outcomes for lessees Star
Page 11 and 12: loss and cash flows. After much bac
Page 13 and 14: The revised dual lessor accounting
Page 15 and 16: Financial Instruments project. Howe
Page 17 and 18: PwC observation: Judgment will be r
Page 19: Time-charter contract: A time chart
Page 23 and 24: The path forward .61 The boards are
Page 25 and 26: Topic Initial ED Revised ED PwC obs

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